The Lost Art of Subtract!

An abridged version of this article was first published in Livemint. Click here to read it

‘Subtracting’ Your Way To Success

In 1948, the McDonald brothers Richard and Maurice, temporarily closed their then barbecue restaurant to streamline the entire operation. When they checked their sales, they discovered that the majority of their business was coming only from a few products (mainly hamburgers). 

Now, they had a bold idea: why not focus only on the best-selling products? 

They cut down their menu from 25 items to just 9!

This move proved to be a game-changer for McDonald’s. By narrowing down their offerings, they could enhance the food quality, lower costs, and serve more customers efficiently. The rest is history!

But it wasn’t just the McDonald brothers. 

When Apple’s Steve Jobs returned in 1997, he axed over 90% of products, leaving only 10. He focused on a few products where Apple could be the best. 

Steve Jobs’s advice to Nike’s new CEO Mark Parker in 2006 illustrates his thinking:

“Nike makes some of the best products in the world. Products that you lust after. But you also make a lot of crap. Just get rid of the crappy stuff and focus on the good stuff.”

The Addition Addiction

When we want to improve something, we have two options.

We can either add new stuff (addition) or take away stuff that’s already there (subtraction). This is true for ideas, products, and situations. 

However, we generally default to thinking about what we can add. Adding feels natural and intuitive while subtracting requires deliberate effort.

So, when trying to improve something, we almost invariably decide to add things without even considering other potential subtractive options. 

But as demonstrated by the McDonald brothers and Steve Jobs, ‘Subtraction’ can sometimes be extremely powerful in creating simple and effective solutions. While there is nothing inherently wrong with adding, if it becomes the only path to improvement, we may be missing out on potentially better solutions.

Applying the Art of ‘Subtract’ to your Equity Portfolios 

Rule No 1: Subtract Choices – “Less but Better”

Create Artificial Constraints

Forgetting the simple fact, that well-diversified equity mutual funds are usually a collection of 30-60 businesses, we try to diversify across several funds. As we keep adding funds, in the name of diversification, we usually end up with several hundred stocks and significant overlap across portfolios. This leads to a cluttered portfolio with individual strategies getting diluted.

A simple solution would be to embrace subtraction via ‘Artificial Constraints’. Create an artificial cap on the total number of equity funds in your portfolio say a maximum of 6-8 Equity funds. Such constraints force prioritization and focus

Minimum 10% Rule

In addition, you can create a minimum 10% rule i.e any fund in your portfolio should be at least 10% of your portfolio. Given that 10% is meaningful, this will force you to deliberate on whether the fund is really required. 

Create ‘IGNORE’ Categories

To reduce your choices, you can create an ‘IGNORE’ list of categories that you feel are not necessary or complicated for your portfolio. For example, you can say no to Sector/Thematic Funds, Multi-Asset Funds (assuming you are already following asset allocation) etc.

Rule No 2: Subtract Decisions – “One decision that removes hundreds”

Create Simple Rules

The biggest drivers of your investment outcome finally boil down to a few simple things: 1) Your Savings Rate 2) Equity Exposure 3) Rebalancing 4) Diversification 5) Time Horizon. 

You can build simple personalized rules around them.

For Eg: Savings Rate >30%, Equity Exposure at 70% (based on risk profile), Rebalance if the deviation exceeds 5%, Diversify across 5 different equity investment approaches (Value, Quality, Growth, Midcap and Global), 7+ year time horizon, etc.

You can also build simple rules around recurring decisions such as ‘how to deploy one-time money’, ‘how to invest monthly’ etc. The rules for how to deploy one-time money can be based on valuations and you can split between immediate deployment and 3-6 months staggered deployment (If you are a FundsIndia Gold Client refer to FundsIndia Deployment Plan sent every month). The higher the valuations higher the portion to be staggered and vice versa.

Create Pre-Loaded Decisions

Most of us tend to panic when the equity market starts to fall. There is an inherent temptation to exit and enter back later at lower levels (a.k.a trying to time the markets). Historical evidence shows that this doesn’t end well as the markets usually recover amidst bad news, before the real economic/earnings recovery, and have a lot of intermittent false upsides making it difficult to differentiate the real recovery from the false upsides. 

Instead of trying to make decisions in the middle of a market fall, you can remove these decisions by planning ahead of time and pre-loading your decisions. The pre-loaded written plan can be as simple as: What should I do if the market falls 10%, 20%, 30%, 40%, and 50%?

Automate Good Decisions

Automate your investment decisions wherever possible. SIP is a great way to automate your monthly investing. It takes out emotions and ensures you continue to invest every month with discipline.

Rule no 3: Subtract Action – “Do Nothing”

Make ‘Do Nothing’ the default

Once you have built the right portfolio and plan, make ‘Do Nothing’ the default action 90% of the time. Keep a high threshold for portfolio action. 

Reduce the frequency of monitoring news and your portfolio

Behavioral Science proves that the less you monitor your portfolio and news, the better. The perennial flow of bad news makes it hard not to react, and the emotional pain of temporary declines also increases as you monitor more frequently.  Portfolio reviews once every 6-12 months should be sufficient if you have built the right portfolio.

Resist the ‘Lure of New’

There is an inherent bias for new stuff over the old. This liking for new takes the form of temptation to add new funds (think NFOs) leading to unnecessary clutter in your portfolio.  

What can you subtract, today?

The Pope asked Michelangelo how he created such a magnificent piece of work out of a block of marble (referring to the statue of David, a masterpiece of Italian Renaissance sculpture).

“It’s simple. I just removed everything that is not David.”

How about you?

Happy Subtracting 🙂